Investors weren't thrilled with the latest earnings report out of Five Below (FIVE -0.70%). Shares of the value-oriented retailer -- which mostly sells items that are $5 and below -- fell after the announcement and are now down over 30% so far in 2022.
Sure, Five Below revealed surprisingly weak customer traffic trends, suggesting a tough period ahead as it approaches the key holiday shopping period. But the stock still remains attractive today, given the chain's bright long-term prospects.
Let's look at a few reasons why you might want to add Five Below to your portfolio.
1. Long-term growth trends
The headline takeaway in Five Below's latest report (for the period ended July 31) was that sales trends came in below management's forecast. Comparable-store sales fell 6% thanks to declining customer traffic and weaker spending per visit. Those are unmistakable warning signs for any growth-focused retailer.
But if you zoom out a bit, you'll see that Five Below's market position is holding up well. Yes, trendy merchandise isn't selling as well as it did a year ago. But the chain's second-quarter sales were still up 50% compared to two years earlier. So this most recent backward step may have more to do with increased traffic a year ago thanks to the government's financial stimulus efforts.
Five Below also has promising growth drivers in the works, including the current rollout of its Five Beyond concept, which features improved tech offerings at attractive prices. The chain isn't likely to keep shrinking for long.
2. Good profits
Five Below isn't facing the same financial challenges as larger retailers like Target are. While consumer demand trends shifted quickly in recent weeks, the chain wasn't forced to slash prices or cancel orders. Instead, gross profit margin declined by just 1.5 percentage points to 34% of sales.
The retailer's bottom line worsened, as you would expect in a period of declining sales and rising expenses. But operating margin is still 8.4%, well above the 4% that Target is generating in 2022. "Our growth and scale continues to benefit us and our customers," CEO Joel Anderson said in a conference call with analysts.
3. A brighter 2023 ahead
The stock price slump can be tied to the fact that management doesn't see a quick ending to the pressures that hurt sales in Q2. Consumers are still more focused on things like travel rather than discretionary retail purchases. And inflation is still shifting spending more toward essentials.
These headwinds convinced management to lower its sales outlook by 3% and reduce earnings expectations by 13%, relative to the prior forecast.
Yet, Five Below is still aggressively adding to its store base, and several of its latest launches ranked among its top openings to date. If executives were seeing evidence of a sustained demand pullback, they wouldn't be planning to open over 200 new locations in 2023.
It is true that the risk profile has risen on this business. Five Below might endure a bad holiday shopping period along with the rest of the retailing niche, further lowering its 2022 sales and earnings. But the more likely scenario I see is that the retailer returns to a more normal growth profile starting next year, thanks to the combination of an expanding store base and rising traffic at existing locations.
Given the stock's lower valuation of 2.5 times sales compared to over four in early 2022, investors might see solid returns simply by holding on through this current bout of volatility.